NB Financial Health

Friday
May 30
2014

James Militzer

Pay for Success: Can social impact bonds provide the fabled “win-win-win”?

Goldman Sachs recently made headlines by investing in Roca, a Massachusetts nonprofit that tries to keep young men out of jail. The investment was notable not just because Goldman was focusing on social impact, but because it also hopes to make a profit. Under the seven-year deal, Roca will try to help 1,000 young men – and if they spend 22 percent fewer days incarcerated than their peers, the state will save enough to pay back Goldman’s $9 million loan. A larger drop in recidivism will earn it up to $1 million in profit. (On the other hand, if Roca’s interventions prove ineffective at keeping men out of jail and prison, the bank will lose almost everything it invested.)

Goldman Sachs’ investment is part of the largest social impact bond or “pay-for-success” effort launched to date in the United States. Pioneered in the United Kingdom, the approach is billed as a way for governments to finance social services during a time of tight budgets. If successful, it could be a prime example of the oft-cited “win-win-win” scenario, bringing benefits to government, investors and service providers, and the public – especially those directly impacted by the social services.

To prepare itself to be a successful candidate for social impact bond/pay for success opportunities, Roca had worked extensively with Third Sector Capital Partners, which describes itself as the leading non-profit advisory firm that’s advancing the mission of performance social sectors in America. Rick Edwards is a partner at the organization, and he spoke with NextBillion Financial Innovation at the recent Sustainatopia conference.

“Pay for success is changing the way governments procure their social services around this country,” he said. “Historically, there have always been what we call cost reimbursement contracts between the government and a social service provider. They tend to pay based on hours, or input, or how many people are treated going into a project or program. What we are doing is converting the mentality of arranging those procurement contracts to what we call outcomes – where the government contracts with that same social service provider, but only pays them based upon measurable outcomes that they achieve, and that are validated.

“There are so many social service programs that are needed in this country,” he continued. “There are urgent social needs that are not being met – not that the government doesn’t want to try to meet them, they just simply don’t have the dollars to allocate to those programs in their budgets. There are trillions of dollars needed … and there just isn’t enough capital to do that. So our role is to bring in philanthropists … and also new financiers, high net worth individuals, banks in the commercial banking sector, sub-debt lenders, so we can really attack these bigger social program issues and scale them. It’s something that historically has worked with grants, but now with the use of outcomes, we’ve got other financiers who are comfortable saying, ’Wait a minute, if you can show me that you actually have an outcome that I can measure with a cash flow, then I can get my debt repaid, and so therefore I’m willing to lend debt dollars against that same project that traditionally only would attract grant dollars.’”

Though this would seem to shift a lot of risk onto service providers, who won’t get paid unless they can demonstrate their effectiveness and who likely can’t absorb the loss as well as the likes of Goldman Sachs, Edwards says this can be an opportunity rather than an obstacle. “There are service providers out there now who are very comfortable with the way they evaluate themselves in metrics or outcomes, and they judge themselves on how well they have a rigorous program to actually measure and achieve outcomes for the population they treat. There are some providers who have not gone to that degree of measurement or self-evaluation yet, [but] I think it’s a healthy issue in the sense that we believe we can work with providers to scale them up, create much more impact with the programs they already have, and also get them comfortable with their own self-measurement.”

But by privatizing funding or services that were formerly public, could the profit motive lead providers to cut corners or inaccurately report their results? Could this lead to less reliable public services over time, if providers and investors withdraw from services that aren’t generating returns and the government is unprepared to step back in? And what could the approach mean for social enterprise? Edwards answers these and other questions in the video below, part two of our Impact Investing Insights series.

You can view part one of the series here.

James Militzer is the editor of NextBillion Financial Innovation.

Categories
Entrepreneurship, Impact Assessment
Tags
financial innovation, impact investing, nonprofit, social impact, social impact bonds, video